Is DigitalOcean Stock A Buy After Its IPO?

DigitalOcean stock began trading on the NYSE in March. The initial public offering brought in $775 million for the company.

Unfortunately, the DigitalOcean IPO did not come too hot out the gate. Initial shares sold for $47, but the price dipped as low as $41 – about 12% lower – once shares went live. The company's prospectus estimated a price somewhere between $44 and $47, and it still has not managed to climb back to that level.

The share price seems to have stabilized at $43 since then. Whether it stays there or not is a different story.

Sometimes, when a stock is lower than anticipated, it could mean a buying opportunity.

Software stocks like DigitalOcean have made a splash in the last year. In 2020, we saw the biggest software IPO in history with Snowflake, hitting $75 billion market cap on opening day.

That means the competition in this space is heavy. The good news, however, is that cloud computing is still a vast, untapped universe of potential for products.

How does DigitalOcean stack up? Let's find out…

What Is DigitalOcean?

DigitalOcean Holdings Inc. (NYSE: DOCN) is a New York-based cloud infrastructure company with servers all around the world.

Cloud infrastructure is basically when you take a bunch of servers to create an exclusive "web" on which to store information and run different kinds of programs. It's kind of like virtual real estate.

A company that owns a cloud network, like DigitalOcean, can sell or rent its server space for others to use as their own virtual networks. Amazon Web Services (AWS) is a big-time example of this. You wouldn't be able to stream Netflix Inc. (NASDAQ: NFLX) if Netflix was not hosted on AWS.

Of course, there are many ways to go about this. Cloud companies can specialize in serving different industries like defense, mobile banking, cloud gaming, and much more.

Cybersecurity is a prevalent use of the cloud in the defense and finance industries, but it's not limited to that. All the functionality of an app, like streaming speed on Spotify, could depend on the quality of the server.

So people want a reliable cloud computing company in their corner. Often, they subscribe to them, like paying rent for a virtual space.

DigitalOcean specifically does this for software developers. With its cloud solution, it wants to give developers the ability to design and deploy applications large scale.

According to Grand View Research, the cloud computing market was $289 billion in 2020 and could grow to $765 billion by 2027. That's 164% industry growth of which DigitalOcean could get a piece if it does everything right.

But anyone entering this market has to contend with Amazon and Microsoft Corp. (NASDAQ: MSFT). Microsoft has also been particularly successful with its Azure cloud platform in the last year.

What separates DigitalOcean from competitors is the praise it gets for being simpler to use. It sells its product in "droplets," a word it uses to describe "slices" of its physical servers.

How Is DigitalOcean Doing?

DigitalOcean is a steadily growing company. It leases 14 data centers in the United States and abroad.

It has expressed a desire to expand this portfolio, and it should do so quickly if it wants to compete with the big dogs. Amazon has around 50 data centers. Microsoft has more than 100 worldwide.

DigitaOceans is also not nearly as profitable as either of those. Cloud companies like Microsoft and Amazon have billions in deferred revenue – that is, advance payment for services yet to be delivered. DigitalOceans had only $5 million in 2020.

Altogether, the company lost over $43 million on $318 million in revenue. To be fair, a company will no doubt have to spend a lot of money for a while if it wants to compete with Big Tech.

In cases like this, you're more interested in seeing the loss shrink, which it did 7% from the prior year. And that's because revenue climbed a solid 25%.

Like any new tech company, its current priority is increasing revenue from customers and cutting R&D costs. Its product currently goes for a cheap $5 a month, so that is certainly possible.

But can it ultimately stay in the game with Big Tech? Let's see…

Is DigitalOcean Stock a Buy?

DigitalOcean hopes to be profitable in 2021. But don't we all?

At its current stage of development relative to competitors, costs and expenses are likely rise over the next few years. This means sales will have to rise, along with maybe the cost of the product.

Something DigitalOcean does have going for it is that the company operates in a novel industry that is virtually untouched albeit for the big names already mentioned. There is plenty of room to innovate.

An overlapping sector here with cloud computing is PaaS (platform-as-a-service), which was worth $6.9 billion in 2020 and could hit $19.2 billion as soon as 2026. That's a whopping 175%.

So, we know at least that this is the right industry to be in. Especially amid the COVID-19 pandemic and after, companies will need more server space to operate entire companies digitally, both to facilitate remote employees and serve customers.

All of that said, investing in DigitalOcean could be a gamble since its valuation proved too high for the moment.

You still want to put this on your radar, though, to see how things play out against other cloud companies that are new to the market, like Snowflake Inc. (NASDAQ: SNOW).

The Digital Ocean stock ticker symbol is "DOCN."

Right now, the DigitalOcean market cap is $4.52 billion, trading at $42.

Disclaimer: Any performance results described herein are not based on actual trading of securities but are instead based on a hypothetical trading account which entered and exited the suggested ...

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